Choosing the Format of a Merger and Acquisition Transaction

Abstract

Mergers and acquisitions are complex transactions that involve many and varied considerations regarding their design, the formulation of their structure and their implementation.

The considerations range between considerations of legal exposure (including financing, employee rights, conversion of existing agreements with suppliers, customers, etc.) and financial considerations, and even the legal ability to perform the transaction.

In this article, we will review the main considerations that must be taken into account when formulating and agreeing on the structure of the transaction, before it is implemented.

Mergers and acquisitions – three main formats[1]

When business firms formulate a merger and acquisition (M&A) transaction, there are three main structures through which the transaction can be performed: (1) a share purchase transaction, (2) an activity or assets purchase transaction, or (3) a merger transaction.

First format – as part of a share purchase transaction, the purchasing company contacts the shareholders of the target company and purchases all (or part) of their shares in the target company. This form of transaction is the least complex transaction to execute since there is no change in the identity of the target company, which continues to independently exist and manage its business. The business activity of the target company, therefore, remains as it was before the transaction was performed. Moreover, there is, apparently (with the required reservations), no difference in the financing arrangements of the target company, the contracts of the target company, the status of its employees, etc.

Second format – as part of an activity/assets purchase transaction, the purchasing company makes an agreement with the target company to purchase its activities and/or assets. Under this form of transaction, the corporate structure of the target company does not change, and in practice it remains as a skeleton (a company without activity, assuming that all of its activity is sold in the transaction), while retaining the proceeds of the sale.

Third format – a merger transaction, and here it is of no consequence whether it is a statutory merger or a merger supervised by a court; this is still the most complex transaction from a legal point of view. Under this framework, the target company is absorbed into the purchasing company, all of the target company’s business and activities, including its assets, financing arrangements, contracts, employees, etc., are assimilated into the purchasing company, and the target company ceases to exist.

In-depth considerations in choosing the framework of the transaction

As we mentioned at the beginning, there are various considerations in choosing the framework of the transaction. In this current article, we have chosen to focus on four key considerations:

Legal liability – as part of the formation of the transaction, the purchasing company aims to reduce its exposure to the risks that are inherent in the transaction, including risks related to the target company and its business. The most convenient and easiest transaction in the context of legal exposures is an asset transaction, since all the exposures related to the target company remain as they were, and the purchasing company acquires the assets and activity in a contractual and informed manner. In contrast, in a merger transaction, all the legal exposures of the target company are transferred to the purchasing company, which upon completion of the transaction becomes the addressee for all the obligations, legal proceedings, contracts, etc. of the target company. Between these two formats is the share transaction, under which, from a legal point of view, the responsibility and legal exposure of the target company’s business remain as they were before the transaction, but the economic consequences actually falls under the corporate structure of the purchasing company as the target company has now become its subsidiary.

Financing arrangements – in most financing agreements (banking financing agreements or otherwise) there are provisions that address possible changes to the corporate structure, the occurrence of which is an event that entitles the lender to immediate payment of the loan/financing that it provided to the company. Thus, in each of the three formats detailed above, the transaction will in most cases be a trigger for the early repayment of the loan. On the other hand, in the share transaction format, the transaction is apparently easier in terms of the financing considerations that are related to the target company, and in light of the transfer of control of the company, questions may arise related to the provision of sureties for the financing, etc. These issues, as well as many other financing related issues, would obviously need to be examined before the transaction is executed.

Regulatory issues – in many transactions, the very identity of the target company is an asset that is important to preserve. The name of the target company is, in many cases, associated with a reputation of significant value; the company number (P.C.) is a threshold condition for the company to win many tenders, and the company’s identity may also be an advantage when it is an authorized supplier for work with public and/or governmental bodies. In the asset purchase format, the purchasing company loses most of these advantages and there are many transactions on which it will not be able to move forward when the asset transaction format is the chosen route, precisely because of the considerations detailed above.

Corporate approvals – the corporate organs that are relevant for performing any transaction in accordance with one of the three formats listed above, may also significantly influence the selection of the preferred format for the transaction. In a share transaction format, for example, the most significant approval that will be required will be the approval of the target company’s shareholders, whilst the approval of the company’s board of directors is the most significant in order to complete an asset transaction. In contrast, in a statutory merger transaction, the approval of both the general meeting of the shareholders and the boards of directors of the two companies will be required in order to proceed with the transaction, and these approvals can prove to be a hurdle that is difficult to surmount. It is necessary, therefore, to first examine the option of using one of the other two formats as possibly the preferred route to complete the transaction.

There are, of course, many additional considerations to be taken when planning and selecting the format of the transaction, but this article is too short to detail them here. The considerations of both parties in executing the transaction may, sometimes, be separate and even opposing considerations, and for this reason it is also important to act in an informed and efficient manner in order to choose the structure that is most appropriate for the specific circumstances of the transaction.

Summary

A merger and acquisition transaction is a complex transaction, and it is very important to act thoroughly and intelligently when planning it and selecting the preferred transaction format. Apart from the commercial conditions for executing the transaction, it is important to understand the set of considerations and circumstances related to both the purchasing company and the target company, and only then to try and plan a transaction that will suit both parties.

[1] We do not address, in this article, mergers and acquisitions with public companies.

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